What to do when the experts don't know anything
By Chris Conklin
Insurance Insight Group
"The first thing we do, let's kill all the lawyers."
--from "Henry VI," William Shakespeare
In 2009, there would likely be a great deal of support for such a proposal -- although today, the idea would be to kill all the financial experts. It seems that almost all the financial innovations we have relied upon in recent years have turned out to be nothing more than houses of cards.
What is a consumer to do to obtain financial security? Who and what can be relied upon for help achieving this goal? And, what assertions can a responsible financial advisor make to a consumer while knowing that he is truly standing on firm ground?
Beliefs we now know to discard
Let's start by examining the primary beliefs that have been recently shattered:
Belief No. 1: Risk can be controlled.
If you open up the 2007-2008 Yearbook of the Securities Industry and Financial Markets Association (SIFMA), the first ranking is a listing of financial firms ranked from largest to smallest based on capital. Since this listing was compiled barely one year ago, the No. 1 firm, Merrill Lynch, has since sold itself under hardship to Bank of America, and No. 4, Lehman Brothers, and No. 6, Bear Stearns, both failed and went out of business.
If these firms, each employing tens of thousands of the best financial minds in the business, could not control their risk enough just to stay in business, how can the average person expect to do so? And, why should the average person rely upon similar firms, their strategies or their advice?
Belief No. 2: Smart management can achieve consistently excellent returns.
On the first page of that same SIFMA Yearbook, in the 35th position is Bernard L. Madoff of Investment Securities LLC. This firm rose to prominence because it was able to consistently deliver above-average returns to its customers, no matter what the economic environment. Its founder and CEO was a very respected figure on Wall Street, a man who could credibly claim to possess the special knowledge required to beat the market.
However, we have since learned that it was all a lie -- a Ponzi scheme that lost perhaps $50 billion in investor funds. And note this: The Madoff firm had 147 employees and 54 registered representatives. How could it be that none of them knew the firm's financial statements were a complete fraud?
Belief No. 3: Invest regularly in your 401(k) and it will take care of your retirement.
One piece of financial advice that had become almost unquestioned is the idea that an employee who consistently invests in an employer's 401(k) plan over the course of his career, and who chooses a well-balanced portfolio of mostly stock mutual funds, will achieve a comfortable retirement. However, the stock market losses of the past year have scuttled a lot of retirement plans.
Even worse comes a report from Boston College's Retirement Research Center, which examined a number of scenarios in which workers had done everything right. In scenarios where a worker contributed 6 percent of their salary to a plan for 40 years invested in a target-date fund, and never touched their savings until retirement, the portion of the pre-retirement income that these savers could replace in retirement varied dramatically depending on when they retired. Those retiring in 1948 could replace 19 percent, 1999 retirees could replace 51 percent, and 2008 retirees could replace 28 percent. Notice that none of these percentages is anywhere near replacing 100 percent of their pre-retirement income.
Belief No. 4: Buying a home is always a good idea.
The belief that it is always a good idea to buy a home led millions of American families to buy homes using whatever mortgage they could afford; whether it was an adjustable-rate mortgage, an interest-only mortgage, or even a negative amortization mortgage. Now, in the face of a recession and dropping real estate values, these families are at best, stuck in their homes due to having less equity than the market value, and at worst, facing foreclosure. But no matter how you look at it, their decision to buy a more expensive home than they could really afford was a big financial mistake.
Time-tested truths we once more respect
The end result of all this is a return to time-tested financial fundamentals. Many beliefs that used to be considered too conservative -- too stodgy, perhaps --are suddenly wise again. And it's true: A financial advisor who makes these recommendations can know that he or she is truly standing on firm ground.
Truth No. 1: Nothing is a guarantee unless it is a guarantee.
When risk cannot be reliably controlled, and when wise management cannot achieve consistently excellent returns, guarantees matter. The good news is that whether you are offering annuities, cash-value life insurance or any other type of product, there usually is an excellent selection of products that provide long-term guarantees and are offered by solid, strong companies. During the boom times, people sometimes lose their focus on guarantees. But today, consumers and advisors can easily see the value of strong, long-term guarantees.
Truth no. 2: Always spend less than you make.
Investing regularly in your 401(k) is good, but it is even better to consistently put money away year after year not only into this kind of retirement account, but also in your general savings. No matter how big an income you produce, if you outspend it, you will be a pauper. How many times have we seen a once-famous athlete or entertainer filing bankruptcy?
Following this truth may mean you drive an older, less impressive car than your neighbor. It may mean that you eat out less. It may mean you live in a more modest home than your coworkers. But it will certainly increase your financial security.
Truth no. 3: Make paying off debt and building your savings a priority.
Make eliminating debt and building savings a central goal of your monetary life. For example, encourage any client who has a debt other than a mortgage to set a goal to have it all paid off within a year. If your client makes that a priority, chances are he can do it. If your client has a mortgage, he should set a goal to have it paid off within ten years. Once your client is totally debt free, he should set a goal to add a particular dollar amount to his savings every year. Whatever the goal is, if it is a high enough priority for him, he is very likely to achieve it. And, after he meets the first goal, you will have instilled in him a very good habit, so achieving other goals will get easier.
Truth No. 4: Control the risks that you can control.
Another area where a financial advisor can really help a client is to perform a risk audit. Take a look at the risks your client faces, help him to examine those risks, and help him to purchase affordable insurance to mitigate those risks. Every family should have life, health, automobile and homeowners insurance. Many families should also have disability, personal umbrella liability and long term care insurance. Too many families are inadequately protected.
It's a risky world. Financial professionals who value guarantees and insurance can help their clients to live comfortably. And that puts everyone on solid ground.
*For further information, or to contact this author, please leave a comment and your e-mail address in the forum below.